Bank of America's reported loss of 15% in third-quarter profits, mainly due to losses in residual value in its automobile leasing portfolio, does not call into question the soundness of outstanding auto-lease securitizations just yet. But observers are carefully watching the industry.

Because residual loss (the value of a car being worth less than expected at the end of a lease term) is not taken into effect until the lease term has been completed, it can be difficult to foresee problems in outstanding securitizations.

BofA stated it has experienced about $75 million per quarter in residual value loss, but the bank "is by no means unique and they're not the first and they won't be the last to experience residual value loss problems," said Joe Astorina, an automobile analyst at Fitch.

He said that many issuers are including a residual value insurance policy on their deals to mitigate residual value risk. For those deals that do not include a policy, "What we do is attempt to size the credit enhancement to fully cover our doomsday scenario in terms of what kinds of residual value losses we might expect to see on an issuer's portfolio," he said.

Recent securitizations by Toyota Motor Credit Corp. and Nissan are two examples of how issuers are handling the problem of residual value loss.

Last year, Toyota experienced larger than expected turn-in rates, since vehicles were coming back earlier than the lease term, and larger than expected residual value losses on those vehicles. Moody's Investors Service put the deal on review.

"Toyota subsequently, in effect, supported those transactions so we were able to not take a rating action on those deals," said Jay Eisbruck, an analyst with Moody's. "But there were concerns about high residual value losses on those auto lease deals."

Nissan, on the other hand, put its additional credit enhancement in the deal initially. However, the company also saw high turn-in rates and residual value loss.

"There are structural things you can do, and they actually had some powerful things in there," said Alex Dill, an analyst at Moody's. "They had an unrated subordinated certificate or note that the interest would be pledged to the reserve account. They had discernable excess credit because they had used a high discount rate, in essence converting principal into interest due to cover losses."

As for other deals in the market, because there are so few of them and they are all recent issues, it will take about a year or two to see how those deals will pan out.

"At the current time, we feel that credit enhancement is sized adequately to cover those potentials," Astorina said. "It's something that we monitor very closely in our surveillance. It's been something that's been going on for quite awhile."

"Some of the issuers who are doing this have gotten a little bit more conservative on setting residuals because of the increase in losses that have occurred over the period," said Eisbruck. "The issue is that the losses you're seeing on residuals today are on leases that they wrote three years ago."

One reason the banks have reported such great losses is that 36-month term leases are just not performing very well.

"They have high turn in rates and they have higher residuals than longer term leases," Dill said. "If you were to look at ... longer term leases like 48 or 60 months, the turn-in rate tends to be lower, the residuals are lower, so there's less exposure at least in an expected case. So it's arguable the triple-A stress we put on it is less than we would on a Nissan or a Toyota deal."

The auto-lease market has been experiencing residual value losses since 1997, and has climbed substantially since then. "The question now is have we reached a point where things have stabilized at a higher level or are they going to continue to increase," added Eisbruck.

Still, the market is not on the verge of a collapse. "We don't think it's doom and gloom for the securitizations, but it is something that is very important and it is something we watch closely," Astorina said.

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